The 1999-2008 Housing Mess: A Diagnosis and Prescription

As any physician will tell you, insightful diagnosis must precede effective prescription. Stated simply, you can't fix problems you don't understand or refuse to recognize. So, to the point of this essay, in purely economic terms where one's ideological faith or partisan political prejudice overrides and dominates a dispassionate grasp of reality (bad diagnosis), one can't establish policies that work (bad prescriptions).

The 2008 housing market collapse and the congenitally weak economy that has followed since then are the disease. To cure both requires an honesty and clarity which will not cast redistributionist progressive actions in good light. It was, in fact, precisely progressive policy that caused this horrendous state of affairs.

The prescriptions that have been written by the Obama Administration to date, however, to address the housing meltdown and weak economy, filled at the Federal Reserve pharmacy -- as detailed in Jon Hall's "A Conversation With Cato The Eldest" -- have failed to cure the problems. They will continue to fail because their diagnosis has been ideologically corrupted and politically prejudiced from the beginning. Blame must be deflected from the guilty. Guilt must be transferred.

Here's the reality. In addition to redistributing wealth and income (welfare) and redistributing outcomes (affirmative action), Democrats sought to redistribute home mortgage loans, which I call "affirmative credit".

With the naming in 1999 of long-time Democrat operative Franklin Raines as its CEO, Democrats turned Fannie Mae into a campaign machine. They redistributed hundreds of billions in mortgage credits by undercutting traditional credit standards... reducing down payments to zero, weakening income and credit score requirements; creating "Liar's Loans" and "No Docs". The goal was to make credit available to people who could never have qualified for a mortgage before, and it succeeded.

This created a huge swell of new housing demand, which drove the housing market into the bubble we all recall. Weak borrowers, however, always create delinquencies, then foreclosures, which destroyed the mortgage derivatives those "Alt-A" and "Sub-Prime" loans underwrote, which in turn destroyed the financial institutions that held the derivatives.

It blew up in the Democrat's faces. "Banksters" and George W. Bush, naturally, got the blame.

Those under-qualified buyers were given loans by political decree. Any "bankster" refusing to make these economically stupid and financially deadly loans was subjected to Congressional and regulatory assault for "discriminatory credit practices". No rational banker refused. George W. Bush tried three times to stop this corrosion through Congressional action and each time was crucified by Democrats, led, you will recall, by Barney Frank in the House and Chris Dodd in the Senate.

An honest diagnosis is that the bastardization of the mortgage credit system was done for progressive political purposes; extending loans to people who would never have qualified for them previously in order to buy votes. When that "affirmative credit" lending stopped in early 2007 housing demand died. The bubble popped. Prices collapsed. Foreclosures soared.

The symptoms of this disease are the collapse of an entire tier of investment banks, the TARPing of most commercial banks, massive job losses, and the weak recovery we've experienced to this day.

With all of this being inarguably, historically true, the prescription is obvious: return to pre-1999, traditional credit standards. End post-1999 redistributionist "affirmative credit" policy. Don't try to force-feed housing demand.

Having convinced just about everyone left and right, however, that all of this was the fault of "banksters", of Wall Street greed and of "1%" crony capitalism, progressives are already back, demanding a rerun of the policies that caused the damage.

The Wall Street Journal's Spencer Jakab noted on Sept 9th in "Mortgage Lending Still on a Tight Leash" (pay wall may exist):

...in the first half of 2014 compared to the same period last year... loans for purchase fell by... 15%. The upshot is that the homeownership rate recently dropped to the lowest point in nearly 20 years.

Jakab refers to credit requirements freezing unqualified buyers out of mortgages as being those of "an overprotective parent"; that standards are unnecessarily tight.

His He makes his case for weakening mortgage credit standards by noting:

Not only is sub-prime auto lending booming but the length of loans has hit unprecedented levels... as long as 84 months.

How far the WSJ has fallen when this passes for brilliance: we're bastardizing the auto loan markets with sub-prime loans right now, so why not mortgages, too.

Binyamin Appelbaum, writing in the New York Times, is more direct. And he represents a large majority of progressives, I have no doubt.

First, he suggests a return to the good old days:

...the Urban Institute, a think tank in Washington, D.C., recently calculated that lenders would have made an additional 1.2 million loans in 2012 had they merely loosened standards to the prevailing level in 2001, well before the industry completely lost its sense of caution.

This is simply false. Credit standards were already badly deteriorated by early 2000 when my wife, a mortgage professional for over 25 years, quit the industry in disgust and dismay at what she saw happening. Returning to 2001 standards would be as disastrous the second time as it was the first.

Appelbaum, in true progressive fashion, then suggests we are all racists if we don't reinstall redistributionist mortgage lending standards:

...mainstream lenders have a long history of using race as a proxy for risk, like the refusal to lend in entire “redlined” neighborhoods. Last week, the attorney general’s office in New York filed suit against a Buffalo lender, Evans Bank, saying it redlined an area of east Buffalo that is home to more than 75 percent of the city’s African-Americans. (Evans Bank has denied this charge.) Similar lawsuits have recently been filed in Los Angeles and Providence, R.I. Goodman and her colleagues found that those excluded from credit in 2012 were disproportionately African-American and Hispanic households.

Translated: we need a return to persecution of lenders for "discriminatory credit practices" with a vengeance.

The drumbeat for a return to the sub-prime credit policies that so dramatically failed from 1999 to 2008 will only get louder as progressive political need to redistribute grows.  Conservative resistance to this renewed demand must be persistent, subtle, and firmly anchored in reality.

Michael Booth, often posting as Cato, lectured in finance and economics at the Univ. of Texas, and worked as a managerial finance trainer in the technology industry for 20 years.